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IMF Warns G-20 About Economic Risks

Risks of prolonged market turmoil in emerging markets and of deflation in the euro area are threatening the world’s improved economic prospects, according to the International Monetary Fund (IMF).

The IMF, in a staff report prepared for central bankers and finance ministers from the Group of 20 (G-20), said the recovery is still weak and “significant downside risks remain.” A January global growth forecast of 3.7 percent for this year, from 3 percent in 2013, hinges on recent market volatility from Turkey to Brazil being short-lived, according to the report.

“Capital outflows, higher interest rates, and sharp currency depreciation in emerging economies remain a key concern,” according to the report prepared ahead of the G-20 meeting February 22 to 23 in Sydney. “A new risk stems from very low inflation in the euro area, where long-term inflation expectations might drift down, raising deflation risks in the event of a serious adverse shock to activity.”

Rising political tensions from Ukraine to Thailand, China’s slowdown, and the Federal Reserve’s tapering of its stimulus have resulted in falling stocks and currencies in emerging markets. Less than two months into 2014, global investors pulled more money out of emerging-market stock and bond funds than the total amount they retracted last year.

To weather the current turbulence, the Washington-based IMF urged developing economies to further increase interest rates when inflation remains high and cut spending when fiscal credibility is lacking.

“Exchange-rate flexibility should continue to facilitate external adjustment, particularly where currencies are overvalued,” IMF staff wrote. Currency intervention, “where reserves are adequate, can be used to smooth excessive volatility or prevent financial disruption.”

Advanced economies must maintain accommodative monetary policy, with the Fed needing to pay particular attention to its communication over the gradual adjustment of its asset purchases, according to the note.

Fed makers plan to soon change their guidance for the path of interest rates as unemployment declines toward a threshold for considering an increase in borrowing costs, minutes of their January meeting showed today.

In the 18-country euro area, which is “turning the corner from recession to a weak recovery,” the fund urged authorities to make it clearer that public backstops will be available for banks that may need funds after stress-test results. That would help the credibility of the test and make it easier for them to raise private capital, it said.

Very low inflation, “if below target for an extended period, could de-anchor longer-term inflation expectations,” the IMF economists wrote. It “also complicates the task in the periphery where the real burden of both public and private debt would rise as real interest rates increased,” they said.

The IMF also suggested cooperative policies to the G-20, which became the premier forum for economic policy discussion in September 2009, in order to raise global growth.

Better coordination between central banks over their exit of unconventional monetary stimulus, combined with measures such as infrastructure investment, changes to labor markets, and policies to boost domestic demand in export countries, could raise the world’s output by 0.5 percentage point a year, or $2.25 trillion, by 2018, the fund said in a separate note.

“Strengthened and cooperative policies would deliver stronger, more balanced, and sustainable medium-term growth while reducing risks of renewed global turmoil,” it said.

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